Australasian Accounting, Business and Finance

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Volume 1 Australasian Accounting Business and
Finance Journal
Article 3
Issue 1 Australasian Accounting Business and Finance
Journal

Assessing the Effects of Product Quality and

Environmental Management Accounting on the
Competitive Advantage of Firms
A. S. Dunk
University of Canberra

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Recommended Citation
Dunk, A. S., Assessing the Effects of Product Quality and Environmental Management Accounting
on the Competitive Advantage of Firms, Australasian Accounting, Business and Finance Journal, 1(1),
2007.

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Assessing the Effects of Product Quality and Environmental Management
Accounting on the Competitive Advantage of Firms
Abstract
Arguments have been made in the literature that product quality provides a basis for establishing and
maintaining a firm’s competitive advantage. Proposals suggest that the framework provided by environmental
management accounting facilitates product quality having the attributes that are likely to contribute to
competitive advantage, and hence it is likely that environmental accounting plays an influential role in that
relation. The purpose of this study is to examine empirically whether there is evidence for environmental
management accounting impacting on the relation between product quality and competitive advantage. These
findings support the view that environmental management accounting has an important role to play in firms.
Specifically, the results of the study suggest that product quality contributes to a firm’s competitive advantage
when the reliance on environmental management accounting is high. However, it fails to do so when the
reliance on environmental management accounting is low.

Keywords
environmental management accounting, product quality, competitive advantage

This article is available in Australasian Accounting, Business and Finance Journal: http://ro.uow.edu.au/aabfj/vol1/iss1/3
 The Australasian Accounting Business & Finance Journal, February 2007 Dunk: Assessing the Effects of
Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

Assessing the Effects of Product Quality and Environmental

Management Accounting on the Competitive Advantage of Firms
Alan S. Dunk
School of Business & Government, University of Canberra

ABSTRACT

Arguments have been made in the literature that product quality provides a basis for
establishing and maintaining a firm’s competitive advantage. Proposals suggest that the
framework provided by environmental management accounting facilitates product quality
having the attributes that are likely to contribute to competitive advantage, and hence it is
likely that environmental accounting plays an influential role in that relation. The purpose of
this study is to examine empirically whether there is evidence for environmental management
accounting impacting on the relation between product quality and competitive advantage.
These findings support the view that environmental management accounting has an
important role to play in firms. Specifically, the results of the study suggest that product
quality contributes to a firm’s competitive advantage when the reliance on environmental
management accounting is high. However, it fails to do so when the reliance on environmental
management accounting is low.

Key words: environmental management accounting; product quality; competitive advantage.

INTRODUCTION
A critical factor reportedly behind product quality initiatives undertaken by many
organizations has been the increasingly global nature of competition (Shank and Govindarajan
1994; Callahan and Lasry 2004). Quality is typically regarded as a key driver of competitive
advantage and hence the enhancement of product quality has been of prime concern to firms
(Daniel et al. 1995; Flynn et al. 1995; Foster and Sjoblom 1996). It has also been a matter of
concern to the management accounting literature, in which studies focusing on learning curves, cost
of quality and zero defect approaches to quality have frequently been featured (for example Malmi
et al. 2004; Foster and Sjoblom 1996). In accounting practice, cost of quality (prevention, appraisal,
internal failure and external failure costs) is a widely used method in the control of quality costs, as
are zero defect approaches to quality (Shank and Govindarajan 1994; Anderson and Sedatole 1998).

Smith and Wright (2004) reported that product quality refers to the extent to which
products meet the expectations of customers, and argued that product quality improvement should
lead to customer satisfaction and higher sales. Product quality typically takes into consideration
product design and customer requirements as well as the environmental attributes of products
(Flynn et al. 1994; Lynch 1999; Porter and van der Linde 1995; Nadia 2001; Wagner 2005). Azzone
and Bertele (1994) indicated that the environmental attributes of products are a critical factor in the
buying behaviors of consumers. The literature suggests that there are also a number of product
quality consequences at the organizational level. For example, Shank and Govindarajan (1994)
argued that quality is widely recognized as a key competitive weapon of firms. Similarly, arguments
have been made that quality provides a basis for establishing and maintaining a global competitive
advantage (for example Porter 1991; Flynn et al. 1995; Terziovski et al. 1999). A firm’s competitive
advantage is defined as the way in which it creates value for its customers, which allows it to

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 The Australasian Accounting Business & Finance Journal, February 2007 Dunk: Assessing the Effects of
Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

establish and sustain a defensible position in its product market (Flynn, Schroeder and Sakakibara
1995).

However, the literature suggests that environmental management accounting may

influence the extent to which product quality contributes to competitive advantage. In one of the
first attempts to focus on environmental management accounting, AT&T defined it as the
integration of environmental factors into management accounting systems, models and practices
throughout an organization (USEPA 1995a). It addresses the importance an organization places on
the reduction or elimination of process waste, the tracing of costs to environmental activities, the
consideration of environmental matters in investment and design decisions, the needs of customers
and other stakeholders, the improvement in compliance with environmental standards, the support
of sustained profit growth, and the identification, reduction, and/or elimination of material with
environmental downsides. The USEPA (1995a) further indicated that it facilitates the identification
and measurement of the cost of environmental materials and activities for use in environmental
management decisions, entailing the collection, recording and distribution of financial and
nonfinancial data.

The USEPA (1995a) argued that environmental management accounting should provide
an effective framework for addressing environmental issues in product design and delivery. Support
for the USEPA (1995a) perspective that organizations can manage environmental issues through
their control systems is contained in the literature (Judge and Douglas 1998; Beets and Souther
1999; Moneva and Llena 2000). For example, evidence indicates that increasingly stringent
environmental standards, prohibitions on the disposal of many wastes, and restrictions on
environmentally unfriendly products are incentives for firms to address environmental issues
through their management control systems (White and Becker 1992; Mannion 1996; Pasurka 2001).
Doing so would be advantageous, as Corrigan (1998) argued that the incorporation of
environmental factors into a firm’s decision processes contributes to the containment of
environmental costs and to the enhancement of an organization’s long-term viability. Consequently,
a reliance on environmental management accounting is likely to influence the relation between
product quality and competitive advantage as it facilitates attention being directed at critical issues
that affect the design and attributes of product output tailored to meet the needs of the market.

The purpose of this study is to examine empirically whether there is evidence for
environmental management accounting impacting on the relation between product quality and
competitive advantage. Doing so would provide evidence of the utility of environmental
management accounting in supporting organizationally desirable outcomes. The management of
environmentally related costs may also be enhanced, as reports indicate that environmental
regulatory costs can be significant. Studies show that companies frequently spend between one and
two percent of their revenues on activities related to the environment (Rugman and Verbeke 1998;
Bailey 1999). Failure to pay attention to environmental issues may expose a firm to sanctions and
penalties, as well as to a reduction in its market capitalization (for example Cormier and Magnan
1997; Burritt et al. 2002). Fekrat et al. (1996) reported that the Institute of Management
Accountants has identified the recognition and disclosure of environmental costs as a priority
management accounting information and cost recognition issue.

The paper proceeds as follows. The next section comprises the literature review, leading
to the development of the hypothesis. The following section describes the research method and the
psychometric analyses of the measures used in the hypothesis test. The subsequent section presents
the results and the final section discusses the conclusions together with the potential limitations of
the study.

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Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

Product quality has been recognized as a strategic organizational priority for some time. For
example, Flynn et al. (1994) argued that quality is a critical component in the design and
manufacture of products which are considered superior to those of competitors. Companies
reportedly pursue product quality on the presumption that it will improve their competitive position,
business success, and differentiate their products (for example Belohlav 1993; Carr 1995). Daniel
and Reitsperger (1991) indicated that a strategic focus on quality has been widely considered as a
fundamental aspect of manufacturing strategy in many firms, and is likely to result in improvements
in product demand thereby facilitating the building and maintenance of a competitive position. Hitt
and Hoskisson (1997) argued that customers increasingly expect products to be of high quality.
Hence, product quality is often considered to contribute to the development of a firm’s competitive
advantage (Benson et al. 1991; Flynn et al. 1994; Judge and Douglas 1998).

The Impact of Environmental Management Accounting

Although product quality is generally expected to contribute to competitive advantage, it is
likely that environmental management accounting plays an influential role in that relation. Based on
work conducted by AT&T, the USEPA (1995a) reported that environmental management
accounting has the potential to improve customer, societal, shareholder, employee, and government
relations by facilitating the meeting or exceeding of environmental expectations. As the benefits of
environmentally conscious design and manufacturing include reduced disposal costs, lower
environmental and health risks, waste minimization and higher productivity (Zhang et al. 1997),
then the framework provided by environmental management accounting contributes to product
quality having the attributes that are likely to contribute to competitive advantage. Gamble et al.
(1996) reported that international action on environmental issues has influenced firms to consider
the manufacture and marketing of products from an environmentally sensitive perspective. The
USEPA (1995b) noted that many environmental costs may be reduced or eliminated by operational
changes, investment in greener technology, and product redesign.

Importantly, Christmann (2004) reported that as public concerns about environmental

issues rise, customers increasingly consider environmental factors in their purchasing decisions.
Decisions involving the choice of materials have an impact on the environment, and studies have
shown that customers increasingly prefer environmentally sound products and avoid those with
environmental downsides during use or disposal (for example Vandermerwe and Oliff 1990; Post
and Altman 1994; Zhang et al. 1997). Research suggests that one significant factor in product
development is identifying user needs and incorporating them into product design (Callahan and
Lasry 2004). Customers expect products to be free of harmful materials, and evidence indicates that
consumers are prepared to pay more for them (Gunningham 1994; Mirvis 1994). Gunningham
(1994) argued that organizations should respond to such evidence on consumer preferences by
redesigning their products to make them less environmentally damaging. It is likely that a firm’s
competitive advantage will benefit from such product quality improvements.

Ranganathan and Ditz (1996) also argued that the provision of environmental cost
information, which is made available through environmental management accounting, can also play
a crucial role in influencing the relation between product quality and competitive advantage. By
focusing on environmental management accounting, the literature suggests that environmental costs
can be reduced or eliminated by product redesign or as a result of investment in greener process
technology USEPA (1995a, b). It is also considered to provide a means of responding to mounting
pressure for firms to track environmental costs (for example Bonifant et al. 1995; White and Savage
1995; Wilmshurst and Frost 1998; Parker 2000). The USEPA (1995a, b) emphasized that the
identification of environmental costs has the potential to promote more accurate product costing and

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 The Australasian Accounting Business & Finance Journal, February 2007 Dunk: Assessing the Effects of
Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

support firms in the design of more environmentally desirable outputs. Judge and Douglas (1998)
reported that firms can often reduce waste and hence cost through the use of environmentally
preferable material substitutes. Environmentally conscious design and manufacturing aims to
reduce disposal costs and environmental risks, improve product quality at lower cost, minimize
waste, and increase productivity (Mannion 1996; Rugman and Verbeke 1998; Zhang et al. 1997).
Brady et al. (1999) argued that competitive opportunities exist for companies that address concerns
for environmental costs. The identification of environmental costs associated with a product
facilitates the reduction or elimination of associated losses and risks and contributes to competitive
advantage (Todd 1995; USEPA 1995a, b).

The conclusion reached in the literature is that the manner in which organizations
address environmental issues can affect the marketability of their products, their competitive
position as well as their financial viability (for example Post and Altman 1992; Billing and Scott
1995). Burritt et al. (2002) indicated that there is increasing stakeholder pressure with respect to the
impact of corporate activities on the environment. Nevertheless, the environment presents
significant competitive opportunities arising from environmentally friendly products (for example
Thornton et al. 2003; Brady et al. 1999). The review of the literature suggests that environmental
management accounting plays a role in influencing the degree to which product quality affects the
competitive advantage of firms. That is, a reliance on environmental management accounting is
likely to result in product quality contributing to a firm’s competitive advantage to a greater extent
than when there is little reliance on environmental management accounting. This hypothesis is
stated in alternate form as follows.

H1: Product quality and environmental management accounting interact to affect competitive
advantage such that when environmental management accounting is high, product quality
enhances a firm’s competitive advantage to a greater degree than when the reliance on
environmental management accounting is low.

METHOD
A random sample of 119 functional area managers was drawn from manufacturing
organizations across Australia listed in Kompass Australia. Industries represented in the sample
include whitegoods, pharmaceuticals, foodstuffs and chemicals. Each manager was contacted by
telephone and requested to take part in the study. On agreeing to do so, each manager was mailed an
anonymous questionnaire together with a cover letter and a stamped addressed envelope for its
return. A telephone follow-up was conducted two weeks later to enhance the response rate. The
follow-up also provided considerable assurance that the targeted managers had themselves
completed the questionnaire.

A total of 77 managers responded, representing a response rate of 65 percent. The

sample comprised 26 marketing and 42 production managers, together with nine other managers
from a range of areas of responsibility. The average age of the respondents was 43, the mean years
of experience in the areas they managed was 12. They had held their present position on average for
four years and the mean number of employees in their areas of responsibility was 78. An
incomplete response was received to the environmental accounting scale, and one to the competitive
advantage measure. Therefore, statistical analyses are based on a sample size of 75.

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 The Australasian Accounting Business & Finance Journal, February 2007 Dunk: Assessing the Effects of
Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

Variable Measurement
Environmental Management Accounting
Environmental management accounting was measured using a ten-item, seven-point
Likert-scaled instrument based on the criteria focused on by AT&T as the attributes of
environmental accounting and reported in USEPA (1995a). An analysis of the literature indicated
that there was no existing measure available. Managers were asked to indicate the degree of
importance, on a scale anchored by (1), of no importance and (7), of great importance, of each of
the items in terms of their company's operations from an environmental perspective. Items included
the reduction or elimination of process waste, tracing costs to environmental activities, compliance
with environmental standards and the reduction or elimination of product material with
environmental downsides. Descriptive statistics for the measure are presented in table 1. The results
of a varimax rotated factor analysis, as reported in table 2, revealed that all items loaded on a single
factor, having an eigenvalue of 5.733, explaining 57.3 percent of the variance in the underlying
variable. The Cronbach alpha for the instrument is 0.928, which indicates that its internal
consistency is high.

Table 1
Descriptive Statistics of the Variables in the Study

Variable n Mean Std Theoretical Actual

Devn Min Max Min Max

Product quality 77 21.325 3.809 4 28 10 28

Environmental accounting 76 49.510 10.840 10 70 18 66

Competitive advantage 76 26.684 4.199 5 35 17 35

__________________________________________________________________________________________

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Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

Table 2
Factor Analysis of Environmental Management Accounting

Item Factor Loading Eigenvalue Percent of

Variance

The reduction or elimination of process waste 0.772

Tracing costs to environmental activities 0.742

Environmental considerations in investment 0.815

decisions/trade-offs

Design decisions influenced by environmental 0.817

considerations

Customers and other stakeholders 0.688

To improve compliance with environmental standards 0.894

To exceed the requirements of environmental standards 0.797

To support sustained profit growth 0.648

The identification of product material with

environmental downsides 0.675

The reduction or elimination of product material with

environmental downsides
0.686 5.733 57.3

Product Quality
Product quality was measured using the four-item, seven point, Likert-scaled Flynn et
al. (1994) instrument. Respondents were asked to indicate on a scale anchored by (1) strongly
disagree and (7) strongly agree, the extent to which they agreed with each of the four items. The
results of a factor analysis, shown in table 3, indicate that the items loaded on a single factor with an
eigenvalue of 1.704, explaining 42.6 percent of the variance in the underlying variable. The
Cronbach alpha of 0.727, consistent with that of Flynn et al.’s (1994) alpha of 0.723, indicates that
the internal consistency of the instrument is relatively high. Descriptive statistics for the measure
are presented in table 1.
Table 3
Factor Analysis of Product Quality (Note: R = reverse-scaled)

Item Factor Loading Eigenvalue Percent of

Variance

New product designs are thoroughly reviewed before

the product is produced and sold 0.797

Customer requirements are thoroughly analyzed in the

new product design process 0.771

Reducing the cost of new products is a more important

priority than new product quality (R) 0.500

On time delivery concerns are more important than

quality in the new product development process (R) 0.474 1.704 42.6

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Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

Competitive Advantage
Competitive advantage was measured using the Flynn et al. (1995) instrument.
Managers were asked to rate the emphasis placed on five Likert-scaled items, anchored by (1), to no
extent and (5) to a great extent. The results of a varimax rotated factor analysis, shown in table 4,
revealed that the five items loaded on a single factor with an eigenvalue of 1.967, explaining 39.3
percent of the variance in the underlying variable. The Cronbach alpha for the scale is 0.740.
Descriptive statistics for the measure are reported in table 1.
Table 4
Factor Analysis of Competitive Advantage

Item Factor Loading Eigenvalue Percent of

Variance

Unit cost of manufacturing 0.651

Fast delivery 0.851

Flexibility to change volume 0.530

Inventory turnover 0.490

Cycle time (from receipt of materials to

shipment) 0.547 1.967 39.3
__________________________________________________________________________________________

RESULTS
The following model was used to test the hypothesis.

Y = b 0 + b1 X 1 + b 2 X 2 + b 3 X 1 X 2 + e (1)

where Y is competitive advantage

X1 is product quality
X2 is environmental management accounting

The question of whether there is an interaction between product quality and

environmental management accounting affecting competitive advantage can be tested by
determining if the coefficient of the interaction term, b3, is different from zero. Panel A of table 5
presents the results of the hypothesis test with all data in continuous form. As b3 is different from
zero (t = 2.32, p = 0.023), the null hypothesis was rejected.

Even though the results shown in panel A of table 5 suggest that product quality and
environmental management accounting interact to affect competitive advantage, further analyses
were undertaken to investigate the nature of the interaction. As a first step in this process,
environmental management accounting was dichotomized at its mean. Scores below the mean
indicate low environmental accounting, whereas scores above the mean reflect high environmental
management accounting. The regression was then re-run with environmental accounting in its
binary form, as shown in panel B of table 5. The results of this procedure indicated that b3 remained
significant (t = 2.02, p = 0.048), thereby facilitating the decomposition of the interaction by this
procedure.

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 The Australasian Accounting Business & Finance Journal, February 2007 Dunk: Assessing the Effects of
Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

Table 5
Results of Hypothesis Test
Panel A: Continuous data

Std
Variable Coefficient Value Error t p

Constant b0 40.910 10.630 3.85 0.001

Product quality (PQ) b1 -0.880 0.496 -1.77 0.080

Environmental accounting (EA) b2 -0.439 0.234 -1.88 0.064

PQ x EA b3 0.025 0.011 2.32 0.023

Adjusted R2 = 0.168, n = 75 F3,71 = 5.99 p = 0.001

Panel B: Environmental management accounting dichotomized: low = 0, high = 1

Std
Variable Coefficient Value Error t p

Constant b0 23.920 3.174 7.54 0.001

Product quality (PQ) b1 0.082 0.155 0.53 0.598

Environmental accounting (EA) b2 -9.773 5.714 -1.70 0.093

PQ x EA b3 0.525 0.261 2.02 0.048

Adjusted R2 = 0.138, n = 75 F3,71 = 4.94 p = 0.004

The regression coefficients in panel B of table 5 were used to construct functional

relations between product quality and competitive advantage when environmental management
accounting is low and when it is high. The two equations are as follows, with environmental
management accounting remaining as X2.
Environmental accounting low: Y = b0 + b1X1 (2)

Environmental accounting high: Y = (b0 + b2) + (b1 + b3)X1 (3)

The insertion of panel B of table 5 regression coefficients into equations (2) and (3) results in the following.

Environmental accounting low: Y = 23.900 + 0.082X1 (4)

Environmental accounting high: Y = 14.200 + 0.607X1 (5)

The interaction between product quality and environmental management accounting

affecting competitive advantage provides support for the differential effect of environmental
management accounting on the relation between product quality and competitive advantage. Given
this interaction, the difference in the slope coefficients in equations (4) and (5) suggests that when

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 The Australasian Accounting Business & Finance Journal, February 2007 Dunk: Assessing the Effects of
Product Quality and Environmental Management. Vol. 1, No.1. pp. 28-38.

the reliance on environmental management accounting is high, product quality is more effective in
enhancing competitive advantage than when environmental accounting is low. However, product
quality is not significant when environmental management accounting is low (t = -0.53, p = 0.598),
but is so when environmental management accounting is high (t = 2.89, p = 0.007). These results
suggest that the relation between product quality and competitive advantage is moderated by
environmental management accounting, and that it is only when environmental management
accounting is high that product quality enhances competitive advantage.

CONCLUSIONS
These findings support the view that environmental management accounting has an
important role to play in firms. Specifically, the results of the study suggest that product quality
contributes to a firm’s competitive advantage when the reliance on environmental management
accounting is high. In contrast, environmental management accounting does not play a moderating
role when organizational reliance is low. Consequently, the development of environmental
management accounting from a management accounting perspective, consistent with the position
taken by the Institute of Management Accountants (Fekrat et al. 1996), should contribute to the
provision of a range of environmental information that is of increasing importance to an array of
corporate stakeholders. However, Herbohn (2005) recently noted that environmental management
accounting is constrained by an ongoing lack of appropriately designed measurement techniques.
Responding to such a constraint is an opportunity for further research.

Although Burritt et al. (2002) argued that management accounting typically does not
give explicit recognition to company-related environmental matters, the perspective put forward by
the USEPA (1995a, b), and followed in this study, may provide a potentially useful framework.
Furthermore, due to the importance of environmental issues, the appropriate reporting of
environmental costs and concerns must be addressed (Gamble et al. 1996), and the issues
encompassed by environmental accounting should contribute to such reporting. As a matter for
further research, Bartolomeo et al. (2000) argued that for management accounting to address
environmental issues effectively, financial and nonfinancial information need to be tracked and
analyzed. They also indicated that a better mechanism for planning and controlling
environmentally-related costs and benefits needs to be determined. Such matters could be pursued
through further research in this field.

A number of limitations may have influenced the results of this study. First, as the
findings are based on cross-sectional data, no statement of causation, and particularly the direction
of causation, can be made. Second, the results may not be generalizable beyond manufacturing
organizations. Third, it may be beneficial to do further psychometric work on assessing the
reliability and validity characteristics of the environmental accounting instrument.

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